wells fargo & company - elizabeth warren · source: company data, nomura estimates after 2014...

Rating Starts at BuyTarget price Starts at USD 60.00

Closing price9 May 2014 USD 49.08

Potential upside +22.2%

Research analysts

Americas Banks

Bill Carcache, CFA, CPA - NSI [email protected] +1 212 298 4117

Key company data: See page 2 for company data and detailed price/index chart

Wells Fargo & CompanyWFC.N WFC US

EQUITY: AMERICAS BANKS

Initiating with Buy Rating and $60 TP

The Shrewd Titan

WFC is Our Top Pick Because It Gives Us Multiple Ways to Win We are initiating coverage of WFC with a Buy rating and $60 target price. If the economic recovery remains muted and loan growth modest, we would expect outperformance to come from a combination of fee income and expense control, supplemented by capital return. If the recovery accelerates and loan growth improves, WFC’s spread income should gap out as yields rise and margins expand on its large, low-cost, sticky deposit base.

We View the Upcoming Investor Day as a Positive Catalyst WFC is accreting capital faster than it can lend or pay it out. We expect WFC to take its payout ratio above the high end of its current 50-65% target range at its May 20 investor day. By our math, WFC would need to increase its payout ratio above 100% for its CET1 ratio to fall below its 9.0% target. We estimate that each 500bp increase in the payout ratio increases EPS by 1%.

Net Interest Income Should Gap Out if Macro Improves With $223bn of excess liquidity at the Fed at 1Q14, WFC’s net interest income would likely gap out in a higher loan growth environment, as it deploys some of that low-cost liquidity into higher yielding loans. By our math, 2014 will be another year of core NIM compression and relatively stagnant NII, as the addition of liquid securities pressures margins but remains P&L neutral. By 2015, we expect a modestly higher fed funds rate to drive WFC’s core NIM back to 2013 levels. If we are right, NII should gap out to the highest levels WFC has ever achieved.

Sustainable Fee Income Stream Offers Protection In an environment of lackluster loan growth and uncertainty over when interest rates will rise, we are tactically overweight fee income and expense control. WFC offers an attractive level of exposure to both. Even excluding mortgage, WFC is over-indexed to fee income relative to peers and enjoys a well above industry average fee income growth outlook. The ability of faster-growth business lines to kick in as others slow has been a hallmark of WFC’s diverse business model and gives us confidence in its sustainability (e.g., mortgage originations were 6% of WFC’s fee income in 1Q14, down from 23% last year, but other businesses such as equity investments, brokerage, and mortgage servicing are now picking up the slack and contributing more to fee income).

Source: Company data, FactSet, Nomura estimates

December Year End 2013 2014E 2015E(Currency US$) Cons. NMR Cons. NMR Cons. NMR

F1Q EPS NA A $0.92 A NA A $1.05 A $1.00 E $1.06 E

F2Q EPS NA A $0.98 A $1.01 E $1.01 E $1.08 E $1.13 E

F3Q EPS NA A $0.99 A $1.02 E $1.02 E $1.10 E $1.15 E

F4Q EPS NA A $1.00 A $1.04 E $1.04 E $1.13 E $1.17 E

EPS NA A $3.89 A $4.11 E $4.11 E $4.30 E $4.50 E

Global Markets Research

13 May 2014

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

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Nomura | Wells Fargo & Company 13 May 2014

2

Key data on Wells Fargo & Company Rating

Stock Buy

Sector Neutral

Relative performance chart

Source: Thomson Reuters, Nomura research

Performance

(%) 1M 3M 12M

Absolute 0.0 8.2 29.5

Relative to S&P Banks Industry Group Index

4.3 7.5 9.9

Market data

Current stock price (USD) 49.08

Market cap (USD - mn) 258,507.8

52-week low (USD) 37.83

52-week high (USD) 50.48

Shares outstanding (mn) 5,267.07

Source: Thomson Reuters, Nomura research

We would like to acknowledge Yuman Lui’s work, which was instrumental in the publication of this report.

WELLS FARGO & COMPANY - SUMMARY OF KEY ITEMS

in millions, except per share amounts 2012 2013 2014E 2015E

Income Statement

Net Interest Income $43,230 $42,800 $43,771 $47,467

Noninterest Income 42,856 40,980 40,127 42,183

Net Revenue 86,086 83,780 83,897 89,649

Noninterest Expenses 50,398 48,842 48,011 49,296

Pre-Provision Net Revenue 35,688 34,938 35,887 40,353

Provision for Credit Losses 7,217 2,309 1,878 3,348

Pretax Earnings 28,471 32,629 34,009 37,005

Net Income 18,897 21,878 23,040 24,763

Net Income Attributable to Common 17,999 20,889 21,896 23,619

YoY Revenue Growth 6.3% (2.7%) 0.1% 6.9%

YoY PPNR Growth 13.1% (2.1%) 2.7% 12.4%

Diluted EPS $3.36 $3.89 $4.11 $4.50

YoY % Growth 19.2% 15.7% 5.6% 9.6%

Key Performance & Operating Metrics

Period-End Loans 799,574 822,286 847,708 884,195

YoY % Growth 3.9% 2.8% 3.1% 4.3%

Net Interest Margin 3.76% 3.39% 3.23% 3.36%

Efficiency Ratio 58.5% 58.3% 57.2% 55.0%

Net Charge-Off Rate 1.17% 0.56% 0.39% 0.43%

ROA 1.41% 1.51% 1.47% 1.50%

ROTE 17.33% 17.81% 16.39% 16.63%

Capital and Other Metrics

Book Value Per Share $27.64 $29.48 $31.47 $33.68

Tangible Book Value Per Share $21.22 $23.64 $26.54 $28.67

Total Payout Ratio 47.1% 54.6% 63.2% 63.5%

Reserve Rate 2.19% 1.82% 1.59% 1.49%

CET1 Ratio (Basel III) 8.2% 9.8% 10.0% 10.3%

Source: Company data, Nomura estimates


3

Investment Case Shrewd risk management and a philosophy of being willing to step aside and slow growth when markets get frothy helped place WFC in a position of strength going into the height of the Great Recession, when it outmaneuvered competitors to complete the acquisition of Wachovia and become a national banking powerhouse. Despite the challenging revenue environment we find ourselves in today, we believe WFC’s diversified business model will continue to generate returns well above the company’s cost of equity. If the economic recovery remains muted and loan growth modest, we would expect outperformance to come from a combination of fee income and expense control, supplemented by capital return. If the recovery accelerates and loan growth improves, WFC’s spread income should gap out as yields rise and margins expand on its large, low-cost, sticky deposit base. Overall, we see room for further share price appreciation and are initiating coverage of WFC with a Buy rating and a $60 price target.

Target Payout Ratio Likely to Increase at Investor Day

We view WFC’s upcoming May 20 investor day as a positive catalyst and would be accumulating shares into it based on our view that the company will take its current payout well above the upper end of its current 50-65% target. While investors are expecting a higher payout ratio, we believe they may be positively surprised by the magnitude of the increase. WFC is accreting capital faster than it can lend it or pay it out. By our math, WFC’s highly capital generative business model will continue to drive the company’s B3 CET1 ratio well above the company’s 9% target, which currently exceeds 10% and is unlikely to fall so long as WFC’s payout ratio remains at the upper end of its current target range. Fig. 1 shows how WFC’s CET1 ratio would decrease as its payout ratio increases. Notably, WFC would need to increase its payout to 115% to lower its CET1 ratio below its 9% target.

Fig. 1: WFC Basel III CET1 Ratio Over Time: Expect Upper End of Payout Ratio Target Range to Increase at Investor Day1 WFC is likely to continue accreting excess capital unless it increases payout levels

1Assumes an equal payout ratio in 2014 and 2015 and an equal payout dollar amount each quarter.


After 2014 CCAR results were released, WFC said it would increase its buyback above the $6bn it repurchased last year but did not provide a specific dollar amount. While it is unclear exactly where WFC’s payout ratio will end up, Fig. 2 shows the impact on 2015 EPS of different payout ratio assumptions, ranging from 65-115%. We estimate that each 500bp increase in the payout ratio increases EPS by 1%; the payout ratio would have to exceed 110% for WFC’s CET1 ratio to fall below the company’s 9.0% target. Fig. 3 shows how WFC’s payout ratio would fare relative to other banks.

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CET1 Target CET1 (w/ 65% payout) CET1 (w/ 75% payout)CET1 (w/ 85% payout) CET1 (w/ 105% payout) CET1 (w/ 115% payout)

CET1 Target of 9.0%

We estimate that WFC will continue to accrete excess capital above its 9% CET1 target unless it takes its target payout ratio above its current 65% level

WFC has room to take its payout ratio as high as ~100%.


4

Fig. 2: 2015 EPS and CET1 Estimates at Different Payouts1 We estimate EPS increases by 1% for each 500bp increase in payout

1Assumes equal payout ratio and quarterly payout dollar amounts in 2014 and 2015.

Source: Nomura estimates

Fig. 3: Expected Payout Ratios in 2Q14-1Q151 We estimate a 69% payout ratio for WFC with room to move higher

1Payout ratios based on consensus estimates for 2Q14-1Q15 as of May 9, 2014. WFC has not disclosed the share repurchase amount included in its capital plan. We assume that it will repurchase $7.7bn of shares from 2Q14-1Q15.


Capital return remains an important element of shareholder value creation in the current environment, and we believe it will contribute to WFC’s ability to continue to generate industry-leading returns, which should ultimately drive further share price appreciation. Fig. 4 and Fig. 5 highlight WFC’s through-the-cycle outperformance over the past 20 years relative to the S&P 500 and BKX. We believe this outperformance is likely to persist as we look ahead.

Fig. 4: 20-Year Share Price Performance: WFC vs. BKX and S&P 5001 WFC shares have outperformed the BKX by 500% over the past 20 years

1Based on share prices through market close on December 31, 2013.

Source: FactSet, Nomura research

Fig. 5: WFC vs. BKX Performance1,2

WFC outperforms broader bank universe

120-year, 15year, 10-year, 5-year performance based on share prices at market close on December 31, 2013. 21-year performance based on share prices for trailing 12 months, ending May 9, 2014.


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CET1 Target of 9.0%

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Although we expect WFC to be more conservative, it has room to take its payout ratio up to 100% in theory.

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BKXK WFC S&P 500

Time Horizon WFC

Outperform / (Underperform) relative to BKX

20-Year 645.0% 491.0%

15-Year 127.4% 141.3%

10-Year 54.2% 83.1%

5-Year 54.0% (2.3%)

1-Year 29.5% 13.0%

YTD 8.1% 10.0%


5

High Fee Income Exposure Offers Protection

In an environment of lackluster loan growth and uncertainty over when interest rates will increase, we are tactically overweight fee income and expense control. WFC offers an attractive level of exposure to both. Fig. 6 and Fig. 7 show that WFC generates the highest percentage of revenues from fee income relative to peers.

Fig. 6: Fee Income as a % of Revenue Over Time1 WFC's fee income has skewed well above the industry average

1Industry average comprises CMA, FITB, HBAN, KEY, MTB, PNC, RF, STI, and USB.


Fig. 7: Fee Income as % of Revs, 1Q14 Fee income accounted for 49% of WFC's revs

Source: Company data, Nomura research

In addition to being over-indexed to fee income relative to peers, WFC also enjoys above industry average fee income growth. Although the company benefitted handsomely by riding the mortgage wave during the refinancing boom, investors have expressed concern over WFC’s ability to continue to grow fee income now that the boom has passed. Fig. 8 and Fig. 9 show that WFC’s fee income businesses, excluding mortgage, also deliver well above industry average growth. The ability of faster-growth business lines to kick in as others slow has been a hallmark of WFC’s diverse business model and gives us confidence in its sustainability (e.g., mortgage originations were 6% of WFC’s fee income this quarter, down from 23% last year, but other businesses such as equity investments, brokerage, and mortgage servicing contributed more to fee income in 1Q14).

Fig. 8: Fee Income Growth Over Time1,2 We expect WFC's fee income growth to continue to outpace the industry

1Fee income adjusted to exclude mortgage banking fees, securities gains/losses, and other non-interest income. 2Industry average comprises CMA, FITB, HBAN, KEY, MTB, PNC, RF, STI, and USB. PNC and MTB data adjusted for the acquisition of RBC Bank and Wilmington, respectively.


Fig. 9: Fee Income Growth, 20131 Non-mortgage fee businesses are driving growth

1Non-interest income adjusted to exclude mortgage banking fees, gains / losses on securities, and other non-interest income.


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Outperformance largely driven by solid growth in trust and investment fees, which grew 13% YoY in 2013

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Within Fee Income, WFC’s Trust and Investment Fees line item includes Brokerage Advisory, Commissions and other Fees; Trust and Investment Management Fees; and Investment Banking Fees. While all have enjoyed attractive growth, we see WFC’s investment banking business as a significant driver of incremental fee income growth as we look to the future. Fig. 10 shows the growing contribution of investment banking fees to non-interest income. More broadly, Fig. 11 shows the growing contribution of trust and investment fees to non-interest income. We expect this topic to receive lots of attention at the upcoming May 20 investor day.

Fig. 10: Investment Banking Fee Contribution to Non-Interest Income We expect investment banking fee contribution to total fee income to become >6% by 2015


Fig. 11: Trust and Investment Fees Contribution to fee income has grown since 2007


Operates One of the Most Efficient Models in Banking

In addition to fee income, expense control is one of the key pillars to our investment thesis in the current environment. Fig. 12 and Fig. 13 show that WFC consistently leads the industry with an efficiency ratio well below the peer average. Only USB, which enjoys the benefit of a high operating leverage payments business, had a lower efficiency ratio at 1Q14.

Fig. 12: Efficiency Ratio Over Time, WFC vs. Industry1,2 We expect further improvement in efficiency and continued outperformance through 2015

1Industry average comprises CMA, FITB, HBAN, KEY, MTB, PNC, RF, STI, and USB. 2HBAN / RF adjusted to exclude a $2.6bn / $6.0bn goodwill impairment charge in 2009 / 2008.


Fig. 13: Efficiency Ratio, 1Q14 WFC ranks second in operating efficiency


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In addition to being highly efficient, WFC also operates one of the most productive business models in banking. The combination of strong fee income and expense control enables WFC to generate industry-leading Pre-Provision Net Revenue (PPNR) as a percentage of average earning assets (AEA).

Fig. 14: Pre-Provision Net Revenue as a % of Average Earning Assets1,2 We expect WFC to maintain a ~70bp lead over the industry through 2015

1Industry average comprises CMA, FITB, HBAN, KEY, MTB, PNC, RF, STI, and USB. 2HBAN / RF adjusted to exclude a $2.6bn / $6.0bn goodwill impairment charge in 2009 / 2008.


Fig. 15: PPNR as % of AEA, 1Q14 WFC ranks second, just 20bps below USB


Net Interest Income Set to Gap Out if Macro Improves

We are not sitting around waiting for better loan growth and higher interest rates and feel quite comfortable owning WFC if the economic environment remains lackluster, particularly given its leverage to fee income and expense control. By the end of 2015, we expect WFC will have tripled its EPS growth from 2010 levels despite flattish pre-provision net revenues (see Fig. 16).

Fig. 16: EPS vs. PPNR Growth We expect WFC to continue delivering EPS growth despite the challenging operating environment


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Although our estimates currently call for flattish PPNR through 2015, the meaningful incremental upside that WFC offers to the extent the macro outlook for banks ever improves is not lost on us. Fig. 17 shows that WFC has the lowest loan-to-deposit ratio in the industry, and Fig. 18 shows that it also enjoys the lowest cost on interest-bearing deposits. With $223bn of excess liquidity at the Fed at 1Q14, WFC’s net interest income would likely gap out in a higher loan growth environment, as it deploys some of that low-cost liquidity into higher yielding loans.

Fig. 17: Comparing Loan-to-Deposit Ratios, 1Q14 WFC has significant liquidity available to deploy into higher yielding assets

Source: SNL Financial, Company data, Nomura research

Fig. 18: Comparing Costs of Interest-Bearing Deposits, 1Q14WFC has the lowest interest-bearing deposit cost among the banks

Source: SNL Financial, Company data, Nomura research

Fig. 19 shows that the size of WFC’s funding advantage relative to the industry has dissipated since the Great Recession, as competitors have taken advantage of the low rate environment to replace high cost consumer funding raised during the crisis. Looking ahead, we would not be surprised to see WFC’s funding advantage once again grow as rates eventually increase and deposits leave the banking system. We view WFC’s deposit base as stickier relative to the overall industry, with convenience and service acting as key drivers in the company’s ability to keep deposit costs relatively low. Fig. 20 gets at one of the core reasons why WFC is able to keep its deposit costs so low; at 1Q14, WFC’s retail banks cross sold 6.16 products per household, up from 5.5 in 2009.

Fig. 19: Average Deposit Cost Over Time1 WFC has consistently enjoyed lower funding costs relative to peers

1Industry average comprises CMA, FITB, HBAN, KEY, PNC, RF, STI, and USB.


Fig. 20: WFC Products Per Household WFC moving towards target of 8 products per HH


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With $223bn of excess liquidity at the Fed (as of1Q14), WFC is w ell-positioned to drive industry-leading earnings grow th w hen it eventually deploys capital into higher yielding loans

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While the magnitude of WFC’s funding advantage has dissipated since the crisis, a rising rate environment that causes deposits to leave the banking system w ould likely drive deposit costs higher. We’d expect WFC to sustain its funding advantage relative to the industry in this kind of environment.

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Fig. 21 shows that WFC deposit growth has outpaced the industry average since 2009 when customers fled to WFC and other quality banks for safety. Fig. 22 shows that WFC maintained its industry-leading growth rate in 1Q14.

Fig. 21: Deposit Growth Rates Over Time1,2 WFC deposits have grown faster than the industry average since 2009

1Industry average comprises CMA, FITB, HBAN, KEY, PNC, RF, STI, and USB. 2Growth rate based on period-end deposits, adjusted for mergers and acquisitions for comparability. Where applicable, period-end deposits prior to an acquisition have been adjusted to include the period-end deposits of the target.


Fig. 22: Deposit Growth Rate, 1Q14 WFC deposits grew at an impressive 8.3%


Effective Balance Sheet Risk Management Provides an Edge

WFC continues to effectively manage the level of risk underlying its portfolio, as evidenced by the reduction in its RWA density ratio (Basel III risk-weighted assets divided by GAAP assets fell from 98% in 4Q12 to 84% in 4Q13). Fig. 23 shows that WFC has the lowest RWA density ratio in the industry.

Fig. 23: Comparing Basel III RWA Density Ratios Across the Industry1 Effective balance sheet management has allowed WFC to maintain the lowest density ratio among peers

1Density ratios based on risk-weighted assets and GAAP total assets as of 4Q13


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RF

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USB

PNC

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MTB

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WFC

84% 85% 86%87%

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WFC RF USB STI HBAN MTB PNC KEY FITB CMA

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WFC's effective management of its balance sheet enables it to maintain one of the lowest density ratios in the industry


10

Effective RWA optimization goes hand in hand with the ability to generate attractive returns on risk-weighted assets. Fig. 24 shows that WFC generates returns on its risk-weighted assets well above the industry average.

Fig. 24: WFC Returns on Risk-Weighted Assets (Basel III) vs. the Industry1 Basel III capital requirements don't change the superior return story



Fig. 25: RoRWA (Basel III), 4Q13 WFC outperformed all, except USB


The story remains unchanged on a GAAP basis. Fig. 26 and Fig. 27 show that WFC’s returns on tangible common equity remain industry leading. With competitors that were taken down by the Great Recession now back up off the mat, it is no surprise that excess returns have dissipated as competition has intensified.

Fig. 26: Returns on Tangible Equity Over Time1 WFC consistently generates industry-leading returns



Fig. 27: Return on Tangible Equity, 1Q14WFC's ROTE is second to just USB


LCR-Driven NIM Compression Appears to Have Bottomed

The gray line in Fig. 28 shows that WFC’s core NIM, which excludes the impact of purchase accounting accretion, has been compressing since 2012. We believe YoY core NIM compression peaked just shy of 55bps in 1Q13 when the company’s liquid assets represented ~32% of its total assets (red line). NIM compression has continued at a decreasing rate as the company has slowed the growth in its liquid asset holdings in an effort to become compliant with LCR rules, which are set to kick into effect at the

0.50%

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USB

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11

beginning of 2015. By our math, 2014 will be another year of core NIM compression and relatively stagnant NII, as the addition of liquid securities pressures margins but remains P&L neutral. By 2015, we expect a modestly higher fed funds rate to drive WFC’s core NIM back to 2013 levels. If we are right, NII should gap out to the highest levels WFC has ever achieved (see Fig. 29).

Fig. 28: NIM Compression Should Abate by Year-End 2014 NIM compression likely to abate after reaching target liquidity levels


Fig. 29: NIM Expansion Expected in 2015 We expect NIM expansion in 2015 to drive meaningful NII growth


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YoY Change in Core NIM Liquid Assets as % of Total Assets

We estimate that core NIM compression troughed in 1Q13 and has since been contracting at a decreasing rate. We expect core NIM expansion to resume in 2015, as pressure abates from LCR-related additions to WFC’s liquid asset holdings.

3.0%

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Net interest income (taxable equivalent) Core NIM

NIMs should expand in 2015 as LCR-driven pressure abates


12

Valuation and Key Risks We are initiating coverage of WFC with a Buy rating and a $60 price target, which implies 2.1x our estimate of 2015 TBVPS of $28.67 and ~13.3x our estimate of 2015 EPS of $4.50. Fig. 30 highlights our assessment of the potential upside / downside associated with the owning the banks under our coverage.

Fig. 30: Initiating coverage of WFC with Buy Rating and $60 Price Target, Based on Our Implied Price of $59.581,2

1MTB’s ROTE is based on our view that the company can maintain a long-term 16% return post-acquisition of HCBK. 2Upside / downside based on share prices at market close on May 9, 2014.


Fig. 31 and Fig. 32 highlight WFC’s historical trading levels on a P/TBV and P/E basis. Overall, we view the 2.1x tangible book multiple inherent in our valuation as reasonable. Although WFC shares have not broken past a 2.0x P/TBV multiple since the Great Recession, we believe that fundamentally shares deserve to trade at 2.1x tangible book, and we expect them to rerate as the company continues to generate superior returns over the coming quarters. We see the May 20 investor day as a near-term catalyst that could drive WFC to break above the 2.0x tangible book mark.

Fig. 31: WFC Historical P/TBV Multiples1 Since 2010, WFC has traded at an average of 1.7x tangible book value

1Based on consensus estimates and share prices through May 9, 2014 market close.

Source: FactSet, Company data, Nomura research

Fig. 32: WFC Historical P/E (NTM) Multiples1 Since 2010, WFC has traded at an average of 10.9x NTM EPS

1Based on consensus estimates and share prices through May 9, 2014 market close.

Source: FactSet, Company data, Nomura research

Prior to the Great Recession, Fig. 33 shows that WFC traded at a premium to the S&P 500. Since 2010, WFC has tended to trade at a discount to the broader market at a multiple of ~0.8x on average. A 2.1x P/TBV multiple implies a valuation of ~0.9x the S&P 500 multiple at current levels.

FY 2015E CMA FITB HBAN KEY MTB PNC RF STI USB WFC

Return on tangible equity 8.4% 13.2% 11.7% 10.4% 16.0% 13.2% 10.6% 10.9% 20.7% 16.6%

÷ Cost of equity 8.5% 8.5% 8.5% 8.5% 7.0% 8.0% 8.5% 8.5% 7.0% 8.0%

Justified P/TBV Multiple 1.0x 1.6x 1.4x 1.2x 2.3x 1.6x 1.2x 1.3x 3.0x 2.1x

x Tangible BVPS $40.48 $15.01 $7.05 $11.38 $64.03 $63.92 $8.92 $31.49 $17.20 $28.67

Implied share price $40.17 $23.28 $9.72 $13.86 $146.36 $105.41 $11.13 $40.51 $50.95 $59.58

Current share price $47.76 $20.55 $9.24 $13.60 $121.37 $84.18 $10.26 $38.00 $40.32 $49.08

Upside / (downside) (15.9%) 13.3% 5.2% 1.9% 20.6% 25.2% 8.5% 6.6% 26.4% 21.4%

Rating Reduce Neutral Neutral Neutral Buy Buy Neutral Neutral Buy Buy

We see value in WFC shares and are initiating coverage with a Buy rating and a $60 target price

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Fundamentally, we think WFC deserves to trade at 2.1x tangible book,andview the upcoming March 20 investor day as a positive catalyst that could help shares break through the 2.0x tangible book level.

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Fig. 33: WFC Trades at a Lower P/E (NTM) Multiple Relative to the S&P 5001 On average, WFC shares have traded at multiples below the S&P 500's

1Based on consensus estimates and share prices through May 9, 2014 market close


Excess Capital

In the current environment, we see little value to excess capital based on our view that (1) much of what is in the system today is trapped and (2) it represents a drag on shareholder returns. As a result, we look favorably on the fact that WFC has one of the lowest levels of excess capital in the industry (see Fig. 35). We estimate that each 100bp increase in WFC’s excess capital as a percentage of its market cap would depress its ROE by ~30bps (see Fig. 34). Fig. 36 breaks our bank universe into four quadrants based on high vs. low payouts and excess capital. WFC finds itself in the most attractive quadrant.

Fig. 35: Excess Capital as a % of Market Capitalization1 WFC has one of the lowest levels of excess capital in the industry

1Excess capital based on risk-weighted assets as of 4Q13 and a target CET1 ratio of 8% under the Basel III Standardized approach (PNC / WFC results are based on a target CET1 ratio of 8.25% / 9.0%; WFC’s binding constraint is B3 Advanced Approach).). Market caps based on share prices as of May 9, 2014.


Fig. 36: Payout Ratio vs. Excess Capital as % of Market Cap1

WFC has a high payout ratio and the low level of excess capital

1Payout ratio based on consensus estimates as of May 9, 2014. Excess capital based on RWA at 4Q13 and CET1 target ratio of 8% under the B3 Standardized Approach (PNC / WFC results based on a CET1 ratio of 8.25% / 9.0%; WFC’s binding constraint is B3 Advanced Approach). Market caps based on share prices as of May 9, 2014.


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WFC P/E Ratio to S&P 500 P/E Ratio Average -1σ +1σ

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Fig. 34: Excess Capital & ROTE

1Excess capital as a % of market capitalization as of May 9, 2014.

Source: Nomura estimates

Excess

Capital12015

ROTE

4.0% 16.5%

5.0% 16.2%

6.0% 15.9%

7.0% 15.7%

8.0% 15.4%

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10.0% 14.9%


14

Nomura vs. Consensus

Fig. 37 compares our estimates vs. consensus for 2014 and 2015. We see ~5% upside to the consensus EPS estimate for 2015.

Fig. 37: Nomura vs. Consensus Estimates1 We see ~5% upside to the consensus EPS estimate for 2015

1Consensus estimates as of May 9, 2014.

Source: FactSet, Nomura estimates

Risks to Our Recommendation and Target Price

Downside risks to our recommendation and target price include a deceleration in economic growth, which further intensifies lack of appetite for credit among consumers and limits commercial investment in working capital, capex, and M&A. Lack of regulator willingness to allow excess capital to leave the system could also lead to meaningful increases in capital levels, which would exert downward pressure on returns and hurt valuations. Significant amounts of deposits could also eventually leave the system as rates increase, which may lead to a larger mix of wholesale borrowings that drives funding costs higher and compresses margins.

(in millions except percentages and per share amounts)

2014E 2015E

NMR Consensus % Difference NMR Consensus % Difference

Net interest income 43,771 43,906 (0.3%) 47,467 46,221 2.7%

Noninterest income 40,127 39,628 1.3% 42,183 41,200 2.4%

Revenue 83,897 83,839 0.1% 89,649 87,808 2.1%

Provision for credit losses 1,878 1,819 (3.2%) 3,348 3,336 (0.4%)

Operating expense 48,011 47,616 (0.8%) 49,296 48,835 (0.9%)

Pretax income 34,009 34,003 0.0% 37,005 35,391 4.6%

Tax expense 10,487 10,500 0.1% 11,841 11,282 (5.0%)

Net income to common 21,896 22,165 (1.2%) 23,619 22,738 3.9%

Diluted EPS $4.11 $4.11 0.1% $4.50 $4.30 4.8%


15

Fig. 38: WFC Earnings Model


Income Statement 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14E 3Q14E 4Q14E 2012 2013 2014E 2015E(in millions, except per share amounts)Net interest income 10,499 10,750 10,748 10,803 10,615 10,818 11,056 11,281 43,230 42,800 43,771 47,467Provision for credit losses 1,219 652 75 363 325 388 518 648 7,217 2,309 1,878 3,348Net interest income after provision for credit losses 9,280 10,098 10,673 10,440 10,290 10,431 10,538 10,633 36,013 40,491 41,893 44,118Total noninterest income 10,760 10,628 9,730 9,862 10,010 10,051 9,965 10,101 42,856 40,980 40,127 42,183

Net revenue 21,259 21,378 20,478 20,665 20,625 20,869 21,021 21,382 86,086 83,780 83,897 89,649

Total noninterest expense 12,400 12,255 12,102 12,085 11,948 12,000 11,982 12,081 50,398 48,842 48,011 49,296

Pre-Provision Net Revenues 8,859 9,123 8,376 8,580 8,677 8,869 9,039 9,301 35,688 34,938 35,887 40,353

Income before income tax expense 7,640 8,471 8,301 8,217 8,352 8,482 8,521 8,653 28,471 32,629 34,009 37,005Income tax expense 2,420 2,863 2,618 2,504 2,277 2,714 2,727 2,769 9,103 10,405 10,487 11,841Net income before noncontrolling interests 5,220 5,608 5,683 5,713 6,075 5,768 5,795 5,884 19,368 22,224 23,522 25,163Less - Net income from noncontrolling interests 49 89 105 103 182 100 100 100 471 346 482 400

Wells Fargo net income 5,171 5,519 5,578 5,610 5,893 5,668 5,695 5,784 18,897 21,878 23,040 24,763Less - Preferred stock dividends and other 240 247 261 241 286 286 286 286 898 989 1,144 1,144Wells Fargo net income applicable to common stock 4,931 5,272 5,317 5,369 5,607 5,382 5,409 5,498 17,999 20,889 21,896 23,619

Effective income tax rate 31.7% 33.8% 31.5% 30.5% 27.3% 32.0% 32.0% 32.0% 32.0% 31.9% 30.8% 32.0%

Diluted earnings per common share $0.92 $0.98 $0.99 $1.00 $1.05 $1.01 $1.02 $1.04 $3.36 $3.89 $4.11 $4.50 Dividends declared per common share $0.25 $0.30 $0.30 $0.30 $0.30 $0.35 $0.35 $0.35 $0.88 $1.15 $1.35 $1.40

Diluted average common shares outstanding 5,354 5,385 5,382 5,359 5,353 5,344 5,321 5,299 5,352 5,370 5,329 5,244

Key Performance and Operating Metrics 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14E 3Q14E 4Q14E 2012 2013 2014E 2015E

% of Net Revenues:Net interest income as % of net revenues 49.4% 50.3% 52.5% 52.3% 51.5% 51.8% 52.6% 52.8% 50.2% 51.1% 52.2% 52.9%Noninterest income as % of net revenues 50.6% 49.7% 47.5% 47.7% 48.5% 48.2% 47.4% 47.2% 49.8% 48.9% 47.8% 47.1%Efficiency ratio 58.3% 57.3% 59.1% 58.5% 57.9% 57.5% 57.0% 56.5% 58.5% 58.3% 57.2% 55.0%Provision 5.7% 3.0% 0.4% 1.8% 1.6% 1.9% 2.5% 3.0% 8.4% 2.8% 2.2% 3.7%

Income Statement:Net interest income YoY % growth (3.6%) (2.6%) 0.8% 1.5% 1.1% 0.6% 2.9% 4.4% 1.1% (1.0%) 2.3% 8.4%Noninterest income YoY % growth 0.1% 3.7% (7.8%) (12.8%) (7.0%) (5.4%) 2.4% 2.4% 12.2% (4.4%) (2.1%) 5.1%Noninterest income YoY % growth (ex mortgage banking) 1.1% 6.3% 4.9% 0.7% 6.7% 8.7% 3.1% 2.9% 2.8% 3.2% 5.3% 4.9%Net revenue YoY % growth (1.7%) 0.4% (3.5%) (5.8%) (3.0%) (2.4%) 2.7% 3.5% 6.3% (2.7%) 0.1% 6.9%Net Interest Margin (taxable equivalent basis), Reported 3.49% 3.47% 3.39% 3.27% 3.20% 3.21% 3.25% 3.28% 3.76% 3.39% 3.23% 3.36%Noninterest expense YoY % growth (4.6%) (1.1%) (0.1%) (6.3%) (3.6%) (2.1%) (1.0%) (0.0%) 2.0% (3.1%) (1.7%) 2.7%Positive (negative) operating leverage 2.8% 1.6% (3.4%) 0.4% 0.7% (0.3%) 3.6% 3.5% 4.3% 0.4% 1.8% 4.2%Net income YoY % growth 22.6% 19.7% 12.7% 10.5% 13.7% 2.1% 1.7% 2.4% 19.8% 16.1% 4.8% 7.9%Diluted EPS YoY % growth 22.2% 19.4% 12.2% 10.1% 13.7% 2.9% 2.9% 3.6% 19.2% 15.7% 5.6% 9.6%

Balance Sheet:Average earnings assets YoY % growth 8.6% 9.8% 9.2% 10.8% 10.6% 8.6% 7.7% 4.2% 5.7% 9.6% 7.7% 4.0%Investment securities YoY % growth 1.5% 5.8% 10.2% 11.8% 7.6% 9.8% 6.8% 5.2% (2.6%) 11.8% 5.2% 3.3%Total Deposits YoY % growth 8.6% 10.0% 9.4% 7.6% 8.3% 8.0% 8.0% 7.5% 9.0% 7.6% 7.5% 5.0%Gross Loans YoY % growth 4.2% 3.2% 3.4% 2.8% 3.5% 3.6% 3.6% 3.1% 3.9% 2.8% 3.1% 4.3%Net Loans YoY % growth 4.5% 3.5% 3.8% 3.2% 4.0% 4.1% 4.0% 3.4% 4.3% 3.2% 3.4% 4.4%

Returns:Return on Assets (ROA), Reported 1.49% 1.55% 1.53% 1.48% 1.57% 1.46% 1.45% 1.45% 1.41% 1.51% 1.47% 1.50%Return on Equity (ROE), Reported 13.59% 14.02% 14.07% 13.81% 14.35% 13.51% 13.44% 13.52% 12.95% 13.87% 13.71% 14.09%Return on Tangible Equity (ROTE) 17.38% 18.23% 18.02% 17.60% 17.44% 16.10% 15.98% 16.05% 17.33% 17.81% 16.39% 16.63%

Credit:Net charge-off rate as % of average total loans 0.72% 0.58% 0.48% 0.47% 0.41% 0.38% 0.39% 0.40% 1.17% 0.56% 0.39% 0.43%Total allowance for credit losses 17,193 16,618 15,647 14,971 14,414 14,014 13,714 13,514 17,477 14,971 13,514 13,164Allowance for credit losses as a % of gross loans 2.15% 2.08% 1.93% 1.82% 1.74% 1.69% 1.64% 1.59% 2.19% 1.82% 1.59% 1.49%Reserve coverage 3.0x 3.6x 4.0x 3.9x 4.4x 4.4x 4.2x 4.0x 1.9x 3.3x 4.1x 3.6x

Capital:Book Value Per Share (BVPS), Reported $28.27 $28.26 $28.98 $29.48 $30.48 $30.54 $31.00 $31.47 $27.64 $29.48 $31.47 $33.68Tangible Book Value Per Share (TBVPS), Calculated $21.78 $21.92 $22.72 $23.64 $25.23 $25.66 $26.09 $26.54 $21.22 $23.64 $26.54 $28.67CET1 Ratio (Basel III) 8.4% 8.6% 9.6% 9.8% 10.1% 10.1% 10.1% 10.0% 8.2% 9.8% 10.0% 10.3%

Capital Return:Total dividend payout ratio (%) 26.7% 30.2% 30.0% 29.4% 28.2% 34.1% 33.8% 33.1% 25.4% 29.1% 32.2% 30.5%Total share repurchases as % of earnings (%) 7.8% 29.5% 38.4% 25.1% 18.3% 35.3% 35.1% 35.5% 21.8% 25.5% 30.9% 33.0%Total payout ratio (%) 34.5% 59.7% 68.4% 54.5% 46.5% 69.4% 68.9% 68.5% 47.1% 54.6% 63.2% 63.5%


16

Appendix A-1

Analyst Certification

I, Bill Carcache, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures

The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers

Issuer Ticker Price Price date Stock rating Sector rating Disclosures Wells Fargo & Company WFC US USD 49.08 09-May-2014 Buy Neutral A1,A2,A3

A1 The Nomura Group has received compensation for non-investment banking products or services from the issuer in the past 12 months.

A2 The Nomura Group had a non-investment banking securities related services client relationship with the issuer during the past 12 months.

A3 The Nomura Group had a non-securities related services client relationship with the issuer during the past 12 months.

Wells Fargo & Company (WFC US) USD 49.08 (09-May-2014) Rating and target price chart (three year history)

Buy (Sector rating: Neutral)

Date Rating Target price Closing price 02-Aug-13 Not Rated 44.49 05-Feb-13 Buy 34.85 05-Feb-13 42.00 34.8527-Jul-12 Not Rated 34.19 29-Mar-12 Buy 33.94 29-Mar-12 38.00 33.9417-Jan-12 30.00 29.8117-Oct-11 29.00 24.4205-Aug-11 31.00 25.21

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Our $60 target price for Wells Fargo (WFC) is based on a P/TBV multiple of 2.1x on our 2015 tangible book value per share estimate of $28.67. The benchmark for this stock is the S&P Banks Industry Group Index.

Risks that may impede the achievement of the target price The key risks to our 12-month target price for Wells Fargo (WFC) include a deceleration in economic growth, which further intensifies lack of appetite for credit among consumers and limits commercial investment in working capital, capex, and M&A. Lack of regulator willingness to allow excess capital to leave the system could also lead to meaningful increases in capital levels, which would exert downward pressure on returns and hurt valuations. Significant amounts of deposits could also eventually leave the system as rates increase, which may lead to a larger mix of wholesale borrowings that drives funding costs higher and compresses margins.

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SECTORSA 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.

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wells fargo & company - elizabeth warren · source: company data, nomura estimates after 2014...

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